Question

An efficient firm employs inputs in such proportions that the marginal product/price ratios for all inputs are equal. In terms of capital budgeting, this implies that the marginal cost of debt should equal the marginal cost of equity in the optimal capital structure. In practice, firms often issue debt at interest rates substantially below the yield that investors require on the firm’s equity shares. Does this mean that many firms are not operating with optimal capital structures? Explain.